ROE

Abbreviation for return on equity. ROE is the ratio of a company's profit to its shareholders' equity, expressed as a percentage. It is the most widely used measure of how well management uses shareholders' funds. Its main advantage is that it is a benchmark that allows investors to compare the profitability of companies in different industries. Investors do not care whether their holdings are in low-margin retailers or high-margin technology companies as long as they produce an above-average ROE. Its main flaw is that it ignores the debt side of the company's funding and thus fails to measure the amount of risk involved in obtaining a given amount of earnings. A high ROE can be due to high earnings or low equity, therefore it is always wise to keep an eye on the company's leverage (as measured by its debt/equity ratio). ROE ratios for healthy companies range between 10 and 25 per cent. Most investors look for companies with double-digit ROEs, or at least higher than the return on a risk-free investment such as a government bond. Companies earning high ROEs will typically attract competition into their market segment and need to keep growing and/or cutting costs to maintain double-digit ROE levels.